profit or loss pre and post incorporations3-ap-southeast-1.amazonaws.com/static.cakart.in/... · 2....

LEARNING OUTCOMES

PROFIT OR LOSS PRE AND

POST INCORPORATION

After studying this unit, you will be able to–

Understand the meaning of pre-incorporation profit or loss;

Account for pre-incorporation profit or loss;

Learn methods for computing profit or loss prior to incorporation.

CHAPTER 5

© The Institute of Chartered Accountants of India

5.2 ACCOUNTING

Pre and Post Incorporation Profits/ Losses

• Profit or loss of a business for the period prior to the date the company came into existence is referred to as Pre-Incorporation Profits or Losses. The chapter deal with the computation of such profits or losses and treatment thereof.

1. INTRODUCTION When a running business is taken over by the promoters of a company, as at a date prior to the date of incorporation of company, the amount of profit or loss of such a business for the period prior to the date the company came into existence is referred to as pre-incorporation profits or losses. Such profits or losses, though belonging to the company or payable by it, are of capital nature; it is necessary to disclose them separately from trading profits or losses.

The general practice in this regard is that:

i. If there is a loss,

(a) it is either written off by debit to the Profit and Loss Account or to a special account described as “Loss Prior to Incorporation” and show as an “asset” in the Balance Sheet,

(b) Alternatively, it may be debited to the Goodwill Account.

ii. On the other hand, if a profit has been earned by business prior to the same being taken over and the same is not fully absorbed by any interest payable for the period, it is credited to Capital Reserve Account or to the Goodwill Account, if any goodwill has been adjusted as an asset. The profit will not be available for distribution as a dividend among the members of the company.

2. COMPUTING PROFIT OR LOSS PRIOR TO INCORPORATION

The determination of such profit or loss would be a simple matter if it is possible to close the books and take the stock held by the business before the company came into existence. In such a case, the trial balance will be abstracted from the

CHAPTER OVERVIEW


5.3

PROFIT OR LOSS PRE AND POST INCORPORATION

books and the profit or loss computed. Thereafter, the books will be either closed off or the balance allowed continuing undistributed; only the amount of profit or loss so determined being adjusted in the manner described above. The simplest, though not always the most expedient method is to close off old books and open new books with the assets and liabilities as they existed at the date of incorporation. In this way, automatically the result to that date will be adjusted, the difference between the values of assets and liabilities acquired and the purchase consideration being accounted for either as goodwill or as reserve. The accounts, therefore, would relate exclusively to the post-incorporation period and any adjustment for the pre-incorporation period, whether an adjustment of profit or loss, would not be required.

Since the decision to take over a business is usually takes time from the date when it is agreed to be taken over it is normally not possible to follow any of the method aforementioned. The only alternative left, in the circumstances, is to split up the profit of the year of the transfer of the business to the company between ‘pre’ and ‘post’ incorporation periods. This is done either on the time basis or on the turnover basis or by a method which combines the two.

3. BASIS OF APPORTIONMENTItem Basis of Apportionment between pre

and Post incorporation period Gross Profit or Gross Loss Sales Ratio-On the basis of turnover in

the respective periods (first preference) Or

On the basis of cost of goods sold in the respective periods in the absence of any information regarding turnover (second preference)

Or Time Ratio-On the basis of time in the respective periods in the absence of any information regarding turnover and cost of goods sold (third preference)

Variable expenses linked with Turnover [e.g. Carriage/Cartage

Sales Ratio


5.4

ACCOUNTING

outward, Selling and distribution expenses, Commission to selling agents/travelling agents, advertisement expenses, Bad debts, Brokerage, Sales Promotion]

Fixed Common charges [e.g., Salaries, Office and Administration Expenses, Rent, Rates and Taxes, Printing and Stationery, Telephone, Telegram and Postage, Depreciation, Miscellaneous Expenses]

Time Ratio

Expenses exclusively relating to pre-Incorporation period [e.g. Interest on Vendor’s Capital]

Charge to pre-incorporation period (but if the purchase consideration is not paid on taking over of business, interest for the subsequent period is charged to post incorporation period)

Expenses exclusively relating to post-incorporation period [e.g. Formation expenses, interest on debentures, director’s fees, Directors’ remuneration, Preliminary Expenses, Share issue Expenses, Underwriting commission, Discount on issue of securities.

Charge to Post-incorporation period

Audit Fees (i) For Company’s Audit under the

Companies Act. Charge to Post-incorporation period

(ii) For Tax Audit under section 44AB of the Income tax Act, 1961

On the basis of turnover in the respective periods

Interest on purchase consideration to vendor:

(i) For the period from the date of acquisition of business to date of incorporation.

Charge to Pre-incorporation period

(ii) From the date of incorporation Charge to Post-incorporation period


5.5


Calculation of time ratio and sales ratio

Example Lion Ltd. was incorporated on 1.8.20X1 to take over the running business of M/s Happy with assets from 1.4.20X1. The accounts of the company were closed on 31.3.20X2.

The average monthly sales during the first four months of the year (20X1-X2) was twice the average monthly sales during each of the remaining eight months.

Calculate time ratio and sales ratio for pre and post incorporation periods.

Solution Time ratio:

Pre-incorporation period (1.4.20X1 to 1.8.20X1) = 4 months

Post incorporation period (1.8.20X1 to 31.3.20X2) = 8 months

Time ratio = 4 : 8 or 1 : 2

Sales ratio:

Average monthly sale before incorporation was twice the average sale per month of the post incorporation period. If weightage for each post-incorporation month is x, then

Weighted sales ratio = 4 × 2x : 8 × 1x = 8x : 8x or 1 : 1

4. PRE-INCORPORATION PROFITS & LOSSES S.

No Pre-incorporation Profits Pre-incorporation Losses

1. It is transferred to Capital Reserve Account (i.e. capitalised).

It is treated as a part of business acquisition cost (Goodwill).

2. It can be used for : • writing off Goodwill on

acquisition • writing off Preliminary Expenses • writing down over-valued assets • issuing of bonus shares • paying up partly paid shares

It can be used for : • setting off against Post-

incorporation Profit • addition to Goodwill on

acquisition • writing off Capital Profit


5.6

ACCOUNTING

Illustration 1 Rama Udyog Limited was incorporated on August 1, 20X1. It had acquired a running business of Rama & Co. with effect from April 1, 20X1. During the year 20X1-X2, the total sales were ` 36,00,000. The sales per month in the first half year were half of what they were in the later half year. The net profit of the company, ` 2,00,000 was worked out after charging the following expenses:

(i) Depreciation ` 1,23,000, (ii) Directors’ fees ` 50,000, (iii) Preliminary expenses ` 12,000, (iv) Office expenses ` 78,000, (v) Selling expenses ` 72,000 and (vi) Interest to vendors upto August 31, 20 X1 ` 5,000.

Please ascertain pre-incorporation and post-incorporation profit for the year ended 31st March, 20X2.

Solution Statement showing pre and post incorporation profit

for the year ended 31st March, 20X2

Particulars Total Amount

Basis of Allocation

Pre-incorporation

Post-Incorporation

` ` ` Gross Profit (W.N.3) 5,40,000 2:7 1,20,000 4,20,000 Less: Depreciation 1,23,000 1:2 41,000 82,000 Director’s Fees 50,000 Post - 50,000 Preliminary Expenses

12,000 Post - 12,000

Office Expenses 78,000 1:2 26,000 52,000 Selling Expenses 72,000 2:7 16,000 56,000 Interest to vendors

5,000 Actual 4,000 1,000

Net Profit (` 33,000 being pre-incorporation profit is transferred to capital reserve Account)

2,00,000

33,000

1,67,000


5.7


Working Notes: 1. Sales ratio

The sales per month in the first half year were half of what they were in the later half year. If in the later half year, sales per month is x then it should be .5 x per month in the first half year. So sales for the first four months (i.e. from 1st April, 20X1 to 31st July, 20X1) will be 4 × .50 = ` 2 and for the last eight months (i.e. from 1st August, 20 X1 to 31st March, 20X2) will be (2 × .50 + 6 × 1) = ` 7. Thus sales ratio is 2:7.

2. Time ratio

1st April, 20X1 to 31st July, 20X1 : 1st August, 20X1 to 31st March, 20X2

= 4 months: 8 months = 1:2

Thus, time ratio is 1:2.

3. Gross profit

Gross profit = Net profit + All expenses

= ` 2,00,000 + ` (1,23,000+50,000+12,000+78,000+72,000+5,000)

= ` 2,00,000 +` 3,40,000 = ` 5,40,000.

Illustration 2 The promoters of Glorious Ltd. took over on behalf of the company a running business with effect from 1st April, 20X1. The company got incorporated on 1st August, 20X1. The annual accounts were made up to 31st March, 20X2 which revealed that the sales for the whole year totalled ` 1,600 lakhs out of which sales till 31st July, 20X1 were for ` 400 lakhs. Gross profit ratio was 25%.

The expenses from 1st April 20X1, till 31st March, 20X2 were as follows:

(` in lakhs)

Salaries 69

Rent, Rates and Insurance 24

Sundry Office Expenses 66

Travellers' Commission 16

Discount Allowed 12


5.8

ACCOUNTING

Bad Debts 4

Directors' Fee 25

Tax Audit Fee 9

Depreciation on Tangible Assets 12

Debenture Interest 11

Prepare a statement showing the calculation of Profits for the pre-incorporation and post-incorporation periods.

Solution Statement showing the calculation of Profits for the pre-incorporation and post-incorporation periods


Basis of Allocation

Pre-incorporation

Post-incorporation

(` in lakhs) (` in lakhs) (` in lakhs)

Gross Profit (25% of ` 1,600)

400 Sales 100 300

Less: Salaries 69 Time 23 46 Rent, rates and Insurance

24 Time 8 16

Sundry office expenses

66 Time 22 44

Travellers’ commission

16 Sales 4 12

Discount allowed 12 Sales 3 9 Bad debts 4 Sales 1 3 Directors’ fee 25 Post - 25 Tax Audit Fees 9 Sales 2.25 6.75 Depreciation on tangible assets

12 Time 4 8

Debenture interest 11 Post - 11 Net profit 152 32.75 119.25


5.9


Working Notes: 1. Sales ratio

(` in lakh)

Sales for the whole year 1,600 Sales up to 31st July, 20X1 400 Therefore, sales for the period from 1st August, 20X1 to 31st March, 20X2

1,200

Thus, sale ratio = 400:1200 = 1:3

2. Time ratio

1st April, 20X1 to 31st July, 20X1 : 1st August, 20X1 to 31st March, 20X2

= 4 months: 8 months = 1:2

Thus, time ratio is 1:2.

Illustration 3 Inder and Vishnu, working in partnership registered a joint stock company under the name of Fellow Travellers Ltd. on May 31, 20X1 to take over their existing business. It was agreed that they would take over the assets of the partnership from January 1st, 20X1 for a sum of ` 3,00,000 and that until the amount was discharged they would pay interest on the amount at the rate of 6% per annum. The amount was paid on June 30, 20X1. To discharge the purchase consideration, the company issued 20,000 equity shares of ` 10 each at a premium of ` 1 each and allotted 7% Debentures of the face value of ` 1,50,000 to the vendors at par.

The summarised Profit and Loss Account of the “Fellow Travellers Ltd.” for the year ended 31st December, 20X1 was as follows:

` ` To Purchase, including

Inventory 1,40,000 By Sales:

To Freight and carriage 5,000 1st January to 31st May 20X1

60,000

To Gross Profit c/d 60,000 1st June to 31st Dec., 20X1

1,20,000

By Inventory in hand 25,000 2,05,000 2,05,000


5.10

ACCOUNTING

To Salaries and Wages 10,000 By Gross profit b/d 60,000 To Debenture Interest 5,250 To Depreciation 1,000 To Interest on purchase

Consideration (up to 30-6-20X1)

9,000

To Selling commission 9,000 To Directors’ Fee 600 To Preliminary expenses 900 To Provision for taxes

(entirely related with company)

6,000

To Dividend paid on equity shares @ 5%

5,000

To Balance c/d 13,250 60,000 60,000

Prepare statement apportioning the expenses and calculate profits/losses for the ‘post’ and ‘pre-incorporation’ periods and also show how these figures would appear in the Balance Sheet of the company.

Solution Fellow Travellers Ltd.

Statement showing calculation of profit /losses for pre and post incorporation periods

Pre- Post- Ratio incorporation incorporation

Gross profit allocated on the basis of sale

1:2 20,000 40,000

Less: Administrative Expenses allocated

On time basis: (i) Salaries and wages 10,000 (ii) Depreciation 1,000 11,000 5:7 4,583 6,417


5.11


Selling Commission on the basis of sales

1:2 3,000 6,000

Interest on Purchase Consideration (Time basis) 5:1 7,500 1,500 Expenses applicable wholly to the Post-incorporation period: Debenture Interest (1,50,000 x 7% x 6/12)

5,250

Director’s Fee 600 5,850 Preliminary expenses 900 Provision for taxes 6,000 Balance c/d to Balance Sheet 4,917 13,333

Time Ratio Pre incorporation period = 1 January 20X1 to 31 May 20X1 = 5 months

Post incorporation period = 1 June 20X1 to 31 December 20X1 = 7 months

Time ratio = 5: 7

Sales Ratio

Sales in pre incorporation period (1 January 20X1 to 31 May 20X1) = ` 60,000

Sales in post incorporation period (1 June 20X1 to 31 December 20X1) = ` 1,20,000

Sales ratio = 1:2

Fellow Travellers Ltd. Extract from the Balance Sheet as on 31st Dec., 20X1

Particulars Notes `

Equity and Liabilities

1 Shareholders' funds

a Share capital 1 2,00,000

b Reserves and Surplus 2 33,250

2 Non-current liabilities

a Long-term borrowings 3 1,50,000


5.12

ACCOUNTING

3 Current liabilities

a Short term provisions 4 6,000

Total 3,89,250

Notes to accounts

` 1. Share Capital 20,000 equity shares of ` 10 each fully paid 2,00,000 2. Reserves and Surplus Profit Prior to Incorporation 4,917 Securities Premium Account 20,000 Profit and loss Account 13,333 Less: Dividend on equity share (5,000) 8,333 Total 33,250 3. Long term borrowings Secured 7% Debentures 1,50,000 4. Other Current liabilities Provision for Taxes 6,000

Illustration 4 The partners of Maitri Agencies decided to convert the partnership into a private limited company called MA (P) Ltd. with effect from 1st January, 20X2. The consideration was agreed at ` 1,17,00,000 based on the firm’s Balance Sheet as at 31st December, 20X1. However, due to some procedural difficulties, the company could be incorporated only on 1st April, 20X2. Meanwhile the business was continued on behalf of the company and the consideration was settled on that day with interest at 12% per annum. The same books of account were continued by the company which closed its account for the first time on 31st March, 20X3 and prepared the following summarised profit and loss account.

` Sales 2,34,00,000 Less: Cost of goods sold 1,63,80,000 Salaries 11,70,000


5.13


Depreciation 1,80,000 Advertisement 7,02,000 Discounts 11,70,000 Managing Director’s remuneration 90,000 Miscellaneous office expenses 1,20,000 Office-cum-show room rent 7,20,000 Interest 9,51,000 2,14,83,000 Profit 19,17,000

The company’s only borrowing was a loan of ` 50,00,000 at 12% p.a. to pay the purchase consideration due to the firm and for working capital requirements.

The company was able to double the average monthly sales of the firm, from 1st April, 20X2 but the salaries tripled from that date. It had to occupy additional space from 1st July, 20X2 for which rent was ` 30,000 per month.

Prepare statement of apportioning cost and revenue between pre-incorporation and post-incorporation periods and calculation of profits/losses for such periods

Solution MA (P) Ltd.

Statement showing calculation of profit/losses for pre and post incorporation periods

Basis of allocation

Pre-inc. Post-inc.

` `

Sales Sales ratio 26,00,000 2,08,00,000

Less: Cost of goods sold Sales ratio 18,20,000 1,45,60,000

Salaries W.N.4 90,000 10,80,000

Depreciation Time ratio 36,000 1,44,000

Advertisement Sales ratio 78,000 6,24,000

Discounts Sales ratio 1,30,000 10,40,000

M.D.’s remuneration Post-inc — 90,000

Misc. Office Expenses Time ratio 24,000 96,000


5.14

ACCOUNTING

Rent W.N.5 90,000 6,30,000

Interest Time ratio 3,51,000 6,00,000

Net Profit/(Loss) (19,000) 19,36,000

Working Notes: (1) Calculation of Sales ratio:

Let the average sales per month in pre-incorporation period be x. Then the average sales in post-incorporation period are 2x. Thus total sales are (3 × x) + (12 × 2x) or 27x. Ratio of sales will be 3x : 24x or 1:8.

Time ratio is 3 months: 12 months or 1:4

(2) Expenses apportioned on turnover ratio basis are cost of goods sold, advertisement, discounts.

(3) Expenses apportioned on time ratio basis are Depreciation, and misc. office expenses.

(4) Ratio for apportionment of Salaries:

If pre-incorporation monthly average is x, for 3 months 3x.

Average for balance 12 months 3x, for 12 months 36x.

Hence ratio for division, 1:12.

(5) Apportionment of Rent:

`

Total Rent 7,20,000 Additional rent for 9 months (From 1st July 20X2 to 31st March, 20X3)

(2,70,000)

Rent for old premises for 15 months at ` 30,000 p.m.

4,50,000

Pre-inc. Post-inc. Old Premises 90,000 3,60,000 Additional rent — 2,70,000 90,000 6,30,000


5.15


Illustration 6 ABC Ltd. took over a running business with effect from 1st April, 20X1. The company was incorporated on 1st August, 20X1. The following summarised Profit and Loss Account has been prepared for the year ended 31.3.20X2:

` `

To Salaries 48,000 By Gross profit 3,20,000 To Stationery 4,800 To Travelling expenses 16,800 To Advertisement 16,000 To Miscellaneous trade

expenses 37,800

To Rent (office buildings) 26,400 To Electricity charges 4,200 To Director’s fee 11,200 To Bad debts 3,200 To Commission to selling

agents 16,000

To Tax Audit fee 6,000 To Debenture interest 3,000 To Interest paid to vendor 4,200 To Selling expenses 25,200 To Depreciation on fixed assets 9,600 To Net profit 87,600 3,20,000 3,20,000

Additional information:

(a) Total sales for the year, which amounted to ` 19,20,000 arose evenly up to the date of 30.9.20X1. Thereafter they recorded an increase of two-third during the rest of the year.

(b) Rent of office building was paid @ ` 2,000 per month up to September, 20X1 and thereafter it was increased by ` 400 per month.

(c) Travelling expenses include ` 4,800 towards sales promotion.


5.16

ACCOUNTING

(d) Depreciation include ` 600 for assets acquired in the post incorporation period.

(e) Purchase consideration was discharged by the company on 30th September, 20X1 by issuing equity shares of ` 10 each.

Prepare Statement showing calculation of profits and allocation of expenses between pre and post incorporation periods.

Solution Statement showing calculation of profits for pre and post incorporation

periods for the year ended 31.3.20X2

Particulars Pre-incorpo-ration period

Post- incorpo-ration period

` ` Gross profit (1:3) 80,000 2,40,000 Less: Salaries (1:2) 16,000 32,000 Stationery (1:2) 1,600 3,200 Advertisement (1:3) 4,000 12,000 Travelling expenses (W.N.4) 4,000 8,000 Sales promotion expenses (W.N.4) 1,200 3,600 Misc. trade expenses (1:2) 12,600 25,200 Rent (office building) (W.N.3) 8,000 18,400 Electricity charges (1:2) 1,400 2,800 Director’s fee (post-incorporation) - 11,200 Bad debts (1:3) 800 2,400 Selling agents commission (1:3) 4,000 12,000 Audit fee (1:3) 1,500 4,500 Debenture interest (post-incorporation) - 3,000 Interest paid to vendor (2:1) (W.N.5) 2,800 1,400 Selling expenses (1:3) 6,300 18,900 Depreciation on fixed assets (W.N.6) 3,000 6,600 Capital reserve (Bal.Fig.) 12,800 - Net profit (Bal.Fig.) - 74,800


5.17


Working Notes: 1. Time Ratio

Pre incorporation period = 1st April, 20X1 to 31st July, 20X1 i.e. 4 months

Post incorporation period is 8 months

Time ratio is 1: 2.

2. Sales ratio

Let the monthly sales for first 6 months (i.e. from 1.4.20X1 to 30.09. 20X1) be x

Then, sales for 6 months = 6x

Monthly sales for next 6 months (i.e. from 1.10.X1 to 31.3.20X2) = x + x32 = x

35

Then, sales for next 6 months = x35 X 6 = 10x

Total sales for the year = 6x + 10x = 16x Monthly sales in the pre incorporation period = ` 19,20,000/16 = ` 1,20,000 Total sales for pre-incorporation period = ` 1,20,000 x 4 = ` 4,80,000 Total sales for post incorporation period = ` 19,20,000 – ` 4,80,000 =

` 14,40,000 Sales Ratio = 4,80,000 : 14,40,000 = 1 : 3 3. Rent

` Rent for pre-incorporation period (` 2,000 x 4) 8,000 (pre) Rent for post incorporation period August,20X1 & September, 20X1 (` 2,000 x 2) 4,000 October,20X1 to March,20X2 (` 2,400 x 6) 14,400 18,400 (post)

4. Travelling expenses and sales promotion expenses

Pre Post ` `

Traveling expenses ` 12,000 (i.e. ` 16,800-


5.18

ACCOUNTING

` 4,800) distributed in Time ratio (1:2) 4,000 8,000 Sales promotion expenses ` 4,800 distributed in Sales ratio (1:3)

1,200 3,600

5. Interest paid to vendor till 30th September, 20X1

Pre Post ` `

Interest for pre-incorporation period ` 4,200 46

×

2,800

Interest for post incorporation period i.e. for

August, 20X1 & September, 20X1 = ` 4,200 26

×

1,400

6. Depreciation

Pre Post ` ` Total depreciation 9,600 Less: Depreciation exclusively for post

incorporation period 600 600

Remaining (for pre and post incorporation period) 9,000

Depreciation for pre-incorporation period 49,000

12 ×

*

3,000

Depreciation for post incorporation period 89,000

12 ×

*

6,000

* Time ratio = 1 : 2 3,000 6,600

Illustration 7 ABC Ltd. was incorporated on 1.5.20X1 to take over the business of DEF and Co. from 1.1.20X1. The summarised Profit and Loss Account as given by ABC Ltd. for the year ending 31.12.20X1 is as under:


5.19


Summarised Profit and Loss Account ` `

To Rent and Taxes 90,000 By Gross Profit 10,64,000

To Salaries including manager’s salary of ` 85,000

3,31,000

By Interest on Investments

36,000

To Carriage Outwards 14,000

To Printing and Stationery 18,000

To Interest on Debentures 25,000

To Sales Commission 30,800

To Bad Debts (related to sales) 91,000

To Underwriting Commission 26,000

To Preliminary Expenses 28,000

To Audit Fees 45,000

To Loss on Sale of Investments 11,200

To Net Profit 3,90,000

11,00,000 11,00,000

Prepare a Statement showing allocation of expenses and calculations of pre-incorporation and post-incorporation profits after considering the following information:

(i) G.P. ratio was constant throughout the year.

(ii) Sales for January and October were 1½ times the average monthly sales while sales for December were twice the average monthly sales.

(iii) Bad Debts are shown after adjusting a recovery of ` 7,000 of Bad Debt for a sale made in July, 20X0.

(iv) Manager’s salary was increased by ` 2,000 p.m. from 1.5.20X1.

(v) All investments were sold in April, 20X1.

(vi) The entire audit fees relates to the company.


5.20

ACCOUNTING

Solution Pre-incorporation period is for four months, from 1st January, 20X1 to 30th April, 20X1. 8 months’ period (from 1st May, 20X1 to 31st December, 20X1) is post-incorporation period.

Statement showing calculation of profit/losses for pre and post incorporation periods

Pre-Inc Post inc ` `

Gross Profit 3,42,000 7,22,000

Interest on Investments 36,000 − Bad debts Recovery 7,000 − 3,85,000 7,22,000 Less : Rent and Taxes 30,000 60,000 Salaries Manager’s salary (85,000- refer note below) 23,000 62,000 Other salaries (3,31,000 – 85,000) 82,000 1,64,000 Printing and stationery 6,000 12,000 Audit fees - 45,000 Carriage outwards 4,500 9,500 Sales commission 9,900 20,900 Bad Debts (91,000 + 7,000) 31,500 66,500 Interest on Debentures − 25,000 Underwriting Commission − 26,000 Preliminary expenses − 28,000 Loss on sale of investments 11,200 − Net Profit 1,86,900 2,03,100

Working Notes: (i) Calculation of Sales ratio

Let average monthly sales be x.

Thus Sales from January to April are 4½ x (i.e., 1.5x + x + x + x) and sales from May to December are 9½ x (x + x + x + x + x + 1.5x + x + 2x).

Sales are in the ratio of 9/2x : 19/2x or 9 : 19.


5.21


Calculation of Time Ratio Pre-incorporation period = 1.1.20X1 to 30.4.20X1 = 4 months Post-incorporation period = 1.5.20X1 to 31.12.20X1 = 8 months Time ratio = 1:2

(ii) Gross profit, carriage outwards, sales commission and bad debts written off (after adjustment for bad debt recovery) have been allocated in pre and post incorporation periods in the ratio of Sales i.e. 9 : 19.

(iii) Rent, salaries (subject to increase in manager’s salary), printing and stationery are allocated on time basis.

(iv) Interest on debentures, underwriting commission and preliminary expenses are allocated in post incorporation period.

(v) Interest on investments, loss on sale of investments and bad debt recovery are allocated in pre-incorporation period.

Note Let Pre-incorporation period manager’s monthly salary be x Total pre-incorporation period manager’s monthly salary = 4x Post-incorporation period manager’s monthly salary = x + 2,000 Total pre-incorporation period manager’s monthly salary = 8(x+2,000) Total manager’s salary (pre and post) = ` 85,000 Thus, 4x + 8(x+2,000) = 85,000 x = 5,750 Total pre-incorporation period manager’s monthly salary = 4 x 5,750 = ` 23,000

Total pre-incorporation period manager’s monthly salary = 8(5,750 + 2,000) = ` 62,000

SUMMARY ♦ Profit or loss of a business for the period prior to the date the company

came into existence is referred to as Pre-Incorporation Profit or Loss.

♦ such profit/ loss is disclosed separately from normal trading profits/losses of the business in the financial statements of the business entity.


5.22

ACCOUNTING

TEST YOUR KNOWLEDGE MCQ 1. Profit prior to incorporation is transferred to

(a) General reserve.

(b) Capital reserve.

(c) Profit and loss account.

2. The profit earned by the company from the date of purchase to the date of incorporation is

(a) Pre- incorporation profit.

(b) Post- incorporation profit.

(c) Notional profit.

3. Loss prior to incorporation is debited to which account?

(a) Goodwill account

(b) Loss prior to incorporation account

(c) Either (a) or (b)

4. Profit prior to incorporation is

(a) Available for distribution as dividend among the members of the company.

(b) Not available for distribution as dividend among the members of the company.

(c) Depends upon the Memorandum of Association.

5. Profit or loss prior to incorporation is of

(a) Revenue nature.

(b) Capital nature.

(c) Nominal nature.

6. Which of the following expenditure is allocated on the basis of time?

(a) Insurance.

(b) Bad debts.


5.23


(c) Discount allowed.

7. Which of the following is allocated on the basis of turnover?

(a) Salaries.

(b) Depreciation.

(c) Gross profit.

8. Preliminary expenses on the formation of the company are charged against

(a) Pre-incorporation profit.

(b) Post- incorporation profit.

(c) Not calculated because of bifurcation of profit into pre and post.

9. Which of the following expense is not allocated on time basis?

(a) Rent

(b) Salaries

(c) Discounts.

THEORETICAL QUESTIONS

1. Define Pre–incorporation profit/loss in brief.

PRACTICAL QUESTIONS Question 1 Sneha Ltd. was incorporated on 1st July, 20X1 to acquire a running business of Atul Sons with effect from 1st April, 20X1. During the year 20X1-X2, the total sales were ` 24,00,000 of which ` 4,80,000 were for the first six months. The Gross profit of the company ` 3,90,800. The expenses debited to the Profit & Loss Account included:

(i) Director's fees ` 30,000

(ii) Bad debts ` 7,200

(iii) Advertising ` 24,000 (under a contract amounting to ` 2,000 per month)

(iv) Salaries and General Expenses ` 1,28,000

(v) Preliminary Expenses written off ` 10,000

(vi) Donation to a political party given by the company ` 10,000.


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ACCOUNTING

Prepare a statement showing pre-incorporation and post-incorporation profit for the year ended 31st March, 20X2.

Question 2

The partners Kamal and Vimal decided to convert their existing partnership business into a Private Limited Company called M/s. KV Trading Private Ltd. with effect from 1-7-20X2.

The same books of accounts were continued by the company which closed its account for first term on 31-3-20X3.

The summarised Profit and Loss Account for the year ended 31-3-20X3 is below:

(`) in lakhs (`) in lakhs Turnover 240.00 Interest on investments 6.00 246.00 Less: Cost of goods sold 102.00 Advertisement 3.00 Sales Commission 6.00 Salary 18.00 Managing director’s remuneration 6.00 Interest on Debentures 2.00 Rent 5.50 Bad Debts 1.00 Underwriting Commission 2.00 Audit fees 2.00 Loss on sale of investment 1.00 Depreciation 4.00 152.50 93.50

The following additional information was provided:

(i) The average monthly sales doubled from 1-7-20X2. GP ratio was constant.

(ii) All investments were sold on 31-5-20X2.


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(iii) Average monthly salary doubled from 1-10-20X2.

(iv) The company occupied additional space from 1-7-20X2 for which rent of ` 20,000 per month was incurred.

(v) Bad debts recovered amounting to ` 50,000 for a sale made in 20X0, has been deducted from bad debts mentioned above.

(vi) Audit fees pertains to the company.

Prepare a statement apportioning the expenses between pre and post incorporation periods and calculate the Profit/Loss for such periods.

Question 3

SALE Limited was incorporated on 01.08.20X1 to take-over the business of a partnership firm w.e.f. 01.04.20X1. The following is the extract of Profit and Loss Account for the year ended 31.03.20X2:

Particulars Amount (`) Particulars Amount (`) To Salaries 1,20,000 By Gross Profit 6,00,000 To Rent, Rates & Taxes 80,000 To Commission on Sales 21,000 To Depreciation 25,000

To Director Fees 12,000 To Advertisement 36,000 To Net Profit for the Year 2,74,000 6,00,000 6,00,000

(i) SALE Limited initiated an advertising campaign which resulted increase in monthly average sales by 25% post incorporation.

(ii) The Gross profit ratio post incorporation increased to 30% from 25%.

You are required to apportion the profit for the year between pre-incorporation and post-incorporation, also explain how pre-incorporation profit is treated in the accounts.


5.26

ACCOUNTING

ANSWERS/ HINTS MCQ

[1. (b), 2. (a), 3. (c), 4. (b), 5. (b),6. (a), 7. (c),8. (b),9.(c)]

THEORETICAL QUESTIONS

1. Refer para 1 of the chapter.

PRACTICAL QUESTIONS

Answer 1 Statement showing the calculation of Profits for the pre-incorporation and post-incorporation periods

For the year ended 31st March, 20X2


Basis of Allocation

Pre-incorporat

ion

Post-incorporat

ion Gross Profit 3,90,800 Sales 39,080 3,51,720 Less: Directors’ fee 30,000 Post - 30,000 Bad debts 7,200 Sales 720 6,480 Advertising 24,000 Time 6,000 18,000 Salaries & general expenses

1,28,000 Time 32,000 96,000

Preliminary expenses 10,000 Post 10,000 Donation to Political Party

10,000 Post 10,000

Net Profit Pre-incorporation profit transfer to Capital Reserve

1,81,600 360

1,81,240

Working Notes:

1. Sales ratio

Particulars ` Sales for period up to 30.06.20X1 (4,80,000 x 3/6) 2,40,000 Sales for period from 01.07.20X1 to 31.03.20X2 (24,00,000 – 2,40,000) 21,60,000

Thus, Sales Ratio = 1 : 9


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2. Time ratio

1st April, 20X1 to 30 June, 20X1: 1st July, 20X1 to 31st March, 20X2

= 3 months: 9 months = 1: 3

Thus, Time Ratio is 1: 3

Answer 2

K V Trading Private Limited

Statement showing calculation of profit/loss for pre and post incorporation periods

` in lakhs

Ratio Total Pre Incorporation

Post Incorporation

Sales Interest on Investments Bad debts recovered

1:6 Pre Pre

240.00 6.00

0.50

34.29 6.00

0.50

205.71 - -

(i) 246.50 40.79 205.71 Cost of goods sold Advertisement Sales commission Salary (W.N.3) Managing directors remuneration Interest on Debentures Rent (W.N.4) Bad debts (1 + 0.5) Underwriting commission Audit fees Loss on sale of Investment Depreciation

1:6 1:6 1:6 1:5

Post Post

1:6

Post Post Pre 1:3

102.00 3.00 6.00

18.00 6.00 2.00 5.50 1.50 2.00 2.00 1.00

4.00

14.57 0.43 0.86 3.00

- -

0.93 0.21

- -

1.00 1.00

87.43 2.57 5.14

15.00 6.00 2.00 4.57 1.29 2.00 2.00

- 3.00

(ii) 153.00 22.00 131.00 Net Profit [(i) – (ii)] 93.50 18.79 74.71

Working Notes:

1. Calculation of Sales Ratio

Let the average sales per month be x


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ACCOUNTING

Total sales from 01.04.20X2 to 30.06.20X2 will be 3x

Average sales per month from 01.07.20X2 to 31.03.20X3 will be 2x

Total sales from 01.07.20X2 to 31.03.20X3 will be 2x X 9 =18x

Ratio of Sales will be 3x: 18x i.e. 3:18 or 1:6

2. Calculation of time Ratio

3 Months: 9 Months i.e. 1:3

3. Apportionment of Salary

Let the salary per month from 01.04.20X2to 30.09.20X2 is x

Salary per month from 01.10.20X2 to 31.03.20X3 will be 2x

Hence, pre incorporation salary (01.04.20X2 to 30.06.20X2) = 3x

Post incorporation salary from 01.07.20X2 to 31.03.20X3 = (3x + 12x) i.e.15x

Ratio for division 3x: 15x or 1: 5

4. Apportionment of Rent ` Lakhs

Total Rent 5.5

Less: additional rent from 1.7.20X2 to 31.3.20X3 1.8

Rent of old premises for 12 months 3.7

Pre Post

Apportionment in time ratio 0.925 2.775

Add: Rent for new space - 1.80

Total 0.925 4.575

Answer 3

Statement showing the calculation of Profits for the pre-incorporation and post-incorporation periods


Basis of Allocation

Pre-incorporation

Post-incorporation

` ` ` Gross Profit (W.N.2) 6,00,000 1:3 1,50,000 4,50,000 Less: Salaries 1,20,000 Time 40,000 80,000 Rent, rates and taxes 80,000 Time 26,667 53,333 Sales’ commission 21,000 Sales (2:5) 6,000 15,000


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Depreciation 25,000 Time 8,333 16,667 Interest on debentures 32,000 Post 32,000 Directors’ fee 12,000 Post 12,000 Advertisement 36,000 post 36,000 Net profit 2,74,000 69,000 2,05,000

Working Notes:

1. Sales ratio Let the monthly sales for first 4 months (i.e. from 1.4.20X1 to 31.7.20X1) be

= x Then, sales for 4 months = 4x Monthly sales for next 8 months (i.e. from 1.8.X1 to 31.3.20X2) = x + 25% of

x= 1.25x Then, sales for next 6 months = 1.25x X 8 = 10x Total sales for the year = 4x + 10x = 14x Sales Ratio = 4 x :10x i.e. 2:5 2. Gross profit ratio From 1.4.20X1 to 31.7.20X1 gross profit is 25% of sales Then, 25% of 4x= 1x gross profit for next 8 months (i.e. from 1.8.X1 to 31.3.20X2) is 30% Then, 30% of 10x = 3x Therefore gross profit ratio will be 1:3 3. Time ratio 1st April, 20X1 to 31st July, 20X1 : 1st August, 20X1 to 31st March, 20X2 = 4 months: 8 months = 1:2 Thus, time ratio is 1:2.


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